Kinh tế vĩ mô Chap 3

Chapter 3 Economic growth

Mentor Pham Xuan Truong



Content
1 Definition, computing method and implications of economic growth
2 Factors decide economic growth in the long run
3 Theories of economic growth
4 Policies to promote economic growth


1 Definition, computing method and implications of
economic growth
Definition
Economic growth is the increase in the market value of the goods and
services produced by an economy over time. It is conventionally measured as
the percent rate of increase in real gross domestic product, or real GDP
To reflect more accurately about living standard of each person in country,
economists use the growth of the ratio of GDP to population (GDP per capita),
which is also called income per capita
An increase in per capita income is referred to as intensive growth. GDP
growth caused only by increases in population or territory is called extensive
growth


1 Definition, computing method and implications of
economic growth
Computing
method

 
+ Absolute growth (in number)
+ Relative growth (in percentage)
Using total real GDP

Using real GDP per capita

Yt − Yt −1
gt =
× 100%
Yt −1

g pct

y t − y t −1
=
× 100%
y t −1


1 Definition, computing method and implications of
economic growth
+ Average growth

y n = y 0 (1 + g a )
ga = n

n

yn

−1
y0

yn GDP at the end of period
y0 GDP in the beginning of period
ga average growth in period
n number of year (month) in period


Rule of thumb: rule of 70
A way to estimate the number of years it takes for a certain variable to
double. The rule of 70 states that in order to estimate the number of years for
a variable to double, take the number 70 and divide it by the growth rate of
the variable (70/g). This rule is commonly used with an annual compound
interest rate to quickly determine how long it would take to double your
money.
If the growth rate is greater than 4% we use 72 for dividing (rule of 72)
Similarly, we have rule of 110 for triple growth and rule of 140 for quadruple
growth


1 Definition, computing method and implications of
economic growth
Implications



Enhance people’s income, thereby improving living standard



Create jobs, mitigate unemployment (Okun’s law)



Provide finance to strengthen national security, political credibility



With low income countries, high economic growth rate helps these country
to catch up high income ones


The variety of growth experiences
Country

Period

Real GDP per person

Real GDP per person

Growth rate

at beginning of period

at end of period

(per year)

Japan

1890–2006

$1,408

$33,150

2.76%

Brazil

1900–2006

729

8,880

2.39

China

1900–2006

670

7,740

2.34

Mexico

1900–2006

1,085

11,410

2.24

Germany

1870–2006

2,045

31,830

2.04

Canada

1870–2006

2,224

34,610

2.04

Argentina

1900–2006

2,147

15,390

1.88

United States

1870–2006

3,752

44,260

1.83

India

1900–2006

632

3,800

1.71

United Kingdom

1870–2006

4,502

35,580

1.53

Indonesia

1900–2006

834

3,950

1.48

Bangladesh

1900–2006

583

2,340

1.32

Pakistan

1900–2006

690

2,500

1.22


2 Factors decides economic growth in the long run
Economic growth in long run means the increase of productivity (quantity of
goods and services produced from each unit of labor input).
Productivity is so important because it is the key determinant of living
standards (an economy’s income is the economy’s output)
The question is how productivity is determined


2 Factors decides economic growth in the long run
How productivity is determined
Physical capital (K)
Stock of equipment and structures
Used to produce goods and services
Human capital (H)
Knowledge and skills that workers acquire through education, training, and
experience
Natural resources (R)
Inputs into the production of goods and services
Provided by nature, such as land, rivers, and mineral deposits

Technological knowledge (T)
Society’s understanding of the best ways to produce goods and services


3 Theories of economic growth
Classical theory

Land plays an important role for economic growth

Production expansion depends on savings of capitalist
Savings of capitalist depends on profit
Profit depends on production cost
Production cost depends on labor cost
Labor cost depends on food price
Food price depends on land area


3 Theories of economic growth

Keynesian
 
theory – Harrod Domar model
Capital accumulation plays an important role for economic growth

According to Harrod – Domar model

g - economic growth, s - national saving rate, k - ICOR (incremental capital output ratio)
index

∆K

ICOR =
∆Y


3 Theories of economic growth
Keynesian theory – Harrod Domar model
Conclusions drawn by Harrod - Domar model:



Economic growth rate (g) has positive relationship with saving rate (s) and
negative relationship with ICOR index (k)



Due to constant k in short run, s is the most determinant of g



There is a trade off between current consumption and future consumption


3 Theories of economic growth
Neoclassical theory – Solow model
We build Solow model from constant return production function Y = f (K,L)
We transform the function:

1
1
1

y = Y . = f ( K . , L. ) = f ( k )
y – products per capita
capita
L or income perL
L
k – capital per capita


3 Theories of economic growth
Neoclassical theory – Solow model
Graph illustrating the relationship between k and y


3 Theories of economic growth
Neoclassical theory – Solow model
Two key questions from the graph



Why pace of output increase becomes slow (slop of production curve)?



How economy overcomes steady state?

Answer two questions



Slow pace of output increase due to diminishing marginal return of capital



To overcome steady state, it requires technological advances


3 Theories of economic growth
Neoclassical theory – Solow model

However technological advance in Solow model is given variable (exogenous
variable). Therefore, Solow model is also called exogenous growth model.


3 Theories of economic growth
Neoclassical theory – Solow model
Catch – up effect (convergence)


3 Theories of economic growth
Neoclassical theory – Solow model
Conclusions drawn by Solow model:



The role of savings for economic growth



Capital accumulation is good for short run economic growth



Technology is the determinant of long run economic growth


3 Theories of economic growth
Modern theory – endogenous model
Later economist (Paul Romer, Grossman, Mankiw…) proposed economic
growth model in which technological advances are determined by R&D
investment, government spending for education, number of workers in
knowledge producing area…
Because now technological advances are internally decided then modern
theory is also called as endogenous growth model


4 Policy to promote economic growth
Saving and investment: Raise future productivity
Invest more current resources in the production of capital
Trade-off: Devote fewer resources to produce goods and services for current
consumption
Investment from abroad: Another way for a country to invest in new capital
Foreign direct investment: Capital investment that is owned and operated
by a foreign entity
Foreign portfolio investment: Investment financed with foreign money but
operated by domestic residents


4 Policy to promote economic growth
Education: Investment in human capital
Gap between wages of educated and uneducated workers

Opportunity cost: wages forgone
Conveys positive externality
Brain drain (problem for poor countries)
Health and nutrition: Healthier workers – more productive
The right investments in the health of the population: One way for a nation
to increase productivity and raise living standards
Historical trends of long-run economic growth: Improved health - from better
nutrition and Taller workers – higher wages – better productivity


4 Policy to promote economic growth
Property rights and political stability: Create favorable institutions
Protect property rights: Ability of people to exercise authority over the
resources they own
Promote political stability
Free trade: Utilize national advantages
Inward-oriented policies: avoid interaction with the rest of the world
Outward-oriented policies: integrate into the world economy


4 Policy to promote economic growth
Research and development : Knowledge – public good that enhances technology

Research Institutes or other science programs funded by government
Research grants
Tax breaks
Patent system
Population growth: Large population create both advantages and disadvantages

Stretching natural resources

Diluting the capital stock
Reduces GDP per worker
But
Promoting technological progress
Large labor force
More consumers


Key concepts












Economic growth
Income per capita
Living standard
Rule of 70
Human capital, Physical capital, Natural resources, Technology advance
Classical theory
Keynesian theory, Harrod – Domar model
Neo-classical theory, Solow model
Steady state

Endogenous model
R&D